Oil and gas are, currently, a staple to the global economy. It’s how we power everything, well maybe not everything. Wind and solar are taking up more share of power generation, but they take up more space and are less consistent. In one barrel of oil alone there are 1,700 kilowatt-hours of energy. To put that into perspective 1 kilowatt of solar panels generates around the same amount of energy in one year. The average home uses around 800-kilowatt hours of energy every month, meaning an oil well producing one barrel a day could heat around 60 houses a month, whereas you would need a ton of acres of land in solar panels to do the same. So it’s no wonder this is what we are hearing more about. I have no question that solar energy and wind energy will be more widely used, but in the meantime, we have to control our current energy issues.
And it’s no wonder oil and gas companies are reaping the rewards of higher oil and gas prices. When the supply of oil and gas is threatened the price goes up, and when the price goes up factories, municipalities, and other energy-using entities want to lock in prices so they won’t have to pay more in the future. These are called swaps, generally, there is a contract between the two parties on how much and for what price the product will be sold for in the future to the other party. So factories in an effort to maintain lower costs in the future because they think the price of energy will rise, like everyone thought, would sign a contract to continue buying energy for say $100 per barrel even when the market price for oil is $75 per barrel.
And that is how you get discrepancies in market prices like this one here.
While the price of oil has fallen to levels not seen since before the war, the values of oil companies are still rising. With how the market prices you would think that because oil is lower the future earnings of companies would be lower and therefore their valuations.
And all of this boils into inflation and the rest of the stock market by the actions Central banks are taking to cool it.
The annual inflation rate in Europe fell in November for the first time since mid-2021 as certain energy prices have dropped to pre-war levels. In Europe, prices for natural gas soared to record highs in August, as nations rushed to stockpile gas supplies for winter. Natural gas is down 60% since then. In the US West Texas Intermediate crude oil was more than $120 per barrel in June, now that price has come back down to $77 per barrel.
The decline in energy prices over the last few months should help ease inflation pressures and potentially set up the Fed, along with other Central Banks, to slow down the pace of interest rate hikes.
However, in the meantime, OPEC+ is convening on December 4th to decide on production policy. A while back OPEC+ announced that they would likely cut the production of oil to boost prices. Another global cut to energy supply could send prices back up to new highs. At Goldman Sach’s commodity division they estimate oil could still reach $200 per barrel in 2023, kind of an outlandish claim but the war in Ukraine is still ongoing and more supply cuts from OPEC+ could damage prices once again.
The Treasury Department said on Saturday it would allow Chevron to resume pumping oil from Venezuela oil fields. The license would allow Chevron to pump Venezuelan oil for the first time in years in joint ventures with Venezuela's national oil company Petróleos de Venezuela. The license prohibits Petróleos de Venezuela from receiving profits from Chevron’s oil sales and the U.S. This move could keep gas prices lower by adding more oil to the global market.
The global framework of oil and gas is extremely interesting right now and US political parties have a vested interest in keeping prices down as many American seem to be basing the achievements of our governing body off the price of energy, per a survey by the New York Times.
But back to the US and our fight with inflation and the price of energy.
Federal Reserve Chairman Jerome Powell in a panel with the Brooking Institute indicated that the Central Bank is on track to raise interest rates by half of a percent in the middle of December, showing signs of an increasingly dovish Fed. Powell also said that an overheated labor market needed to cool more for the Fed to be confident that inflation will continue falling.
The Fed has reviewed signs of progress on the inflation fight, including a slowdown interest-rate-sensitive sectors of the economy such as housing and improving supply-chain conditions. But he said that declines in goods prices and rents, which have contributed notably to inflation over the last 18 months, might be insufficient if firms don’t slow their hiring. The uptick in the number of headlines that state companies are starting to lay off employees indicates that the Fed’s efforts are starting to show.
So what they are most worried about is labor demand not the price of energy.
The overheating part of the labor market is on the employer demand side. Job openings have been far out of balance with the supply of available workers, but job openings are far easier to unravel. Just think in order to keep the same number of employed people all you have to do is make companies not want any more people. And that is broadly what we are seeing. Apple, Disney, Amazon, and Google, all these companies have either laid off some employees or froze hiring in 2022. A clear win for the US economy, sort of weird to be able to say that.
December is typically a good month for the stock market. The average move for the S&P 500 in December is a gain of about 1.7% since 1928, according to Dow Jones market data. The month is typically referred to as the “Santa Claus rally” because the end of the year is usually when people fund their retirement accounts, which brings new money into the markets.
What would cause this norm to change would be what the November inflation data comes in at. If inflation is stronger than expected markets would assume the Fed would have to take a still aggressive path forward.
That is what these markets are all about the Fed and inflation, once we are past that, it should be smooth sailing, it's just hard to say when that will be.
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